Pick up any newspaper and you will surely see an article on why, when, how or if government is going to save the economy, small business, the farmers, the currency and/or the marginal seats by reducing interest rates. Every statement by Reserve Bank or Treasury officials is analysed for hidden clues; every mis-statement by every loose-lipped politician flashes quickly around the world on the dealers’ screens; every monetary statistic is seen as a reason for the price of money and other assets to rise and fall. Fortunes, and the reputation of forecasters, are made and lost on correct calls on the size and direction of the next government interest rate fiddle.
Judging from their monetary policies, and their morbid pre-occupation with throttling interest rates, most politicians would probably agree with James Lowell who said “I don’t believe in principle, but I do believe in interest”.
Interest is merely the price of money, so manipulation of interest rates is just another form of price control, and just as destructive and distorting. And the consequences are always perverse.
Attempts to control the price of money go back into prehistory.
During the Middle Ages and before, the payment and receiving of interest (or usury) was prohibited in most Christian and Moslem societies. As few people are prepared to lend money for no interest, these bans on usury merely reduced the amount of money saved or lent, and left the money-lending business to the Jews, who had no such stupid scruples. And only those in desperation sought out the despised moneylenders — governments during wartime and the poor during famines.
Money is the mother’s milk of trade. Trade flourishes on a steady diet of good mother’s milk, and dies if it dries up. Sound money retains its value and encourages savings, investment and trade. But since the dawn of the Century of Inflation (it started with the Great War, in 1914), governments have tried to monopolise the production and supply of monetary mother’s milk by keeping it all in a big tub under a leaky tap. Timid taxpayers arrive each day to add to the tub by the bucketful.
Every election, there is a fight to buy votes by showering everyone with cheap mother’s milk. The tap is turned on and watery milk overflows into the troughs around the monetary milk-room.
This produces a mad scramble around the troughs for the free milk, and the watery stuff becomes less valuable to all who are forced by legal tender laws to use it as a trading instrument. Occassionally, one pig gets into the milk-room and jumps right into the tub, causing a great flood. When they get him out, the overseers have to crack their whips to speed up the long lines of tax slaves shuffling to the half-empty tub with their contributions of milk. When even the whips on taxpayers and the bribing of money-lenders fail to fill the tub, the tap is turned on.
Two groups are always in favour of watering the monetary milk — habitual borrowers, and those with their noses in the government troughs. The debtors like to repay the money-lenders in devalued watery milk, and the pigs like to see plenty of overflow, even if it is a bit watery.
Those who loan money are aghast whenever the tap is turned on and immediately demand a higher price for loaning full-cream milk and getting repaid in watery whey. We thus see the first factor pushing up the price of money — inflationary fears by lenders.
Governments of course, deny that any dilution is going to the Treasury milk-room. All doors are locked and the shutters closed. Only the high priests are allowed to touch the tap. Uncertainty, coupled with well-founded suspicion as to where all the slops are coming from, causes lenders to add a risk premium to the asking price for those wanting to borrow their milk.
Half-hearted deregulation of the world monetary and banking system has had one very unfortunate result — it has left interest rate manipulation as one of the few levers left to government.
Because borrowers are always more numerous and often more desperate and vocal than lenders, the reality of vote buying indicates that government interventions are always biased towards keeping the price of money below its market rate.
This causes short-term joy for lenders but long-term problems for everyone.
Firstly, cheap money discourages saving and encourages consumption. It also penalises the thrifty and rewards the over-borrowed. It is usually achieved by watering the monetary milk, which causes holders of money to exchange it for real assets — this causes inflation in the price of real assets, even unproductive ones like palatial houses, works of art, coin collections and jewellery.
Borrowing allows consumers to live beyond their means, for a time. But once the money is spent on boats, cars and renovations, the repayments have to start. Payback will force a decline in debtors’ living standards. Consumption slows and retailers feel the squeeze. Business also declines as those who live on the now reduced interest earned from their savings tighten their belts. There are more calls for “cheaper money to encourage business”. But despite the cheap money, business does not improve because ever more debtors are reducing their living standards to repay past debts. As the Japanese have found, you can’t push the business dog with the interest rate leash — leashes are only effective in holding an exuberant dog in check. A stick or frightened dog won’t run even on a loose leash — it’s like pushing on a string.
The ancient phobia about usury is still reflected in laws about the maximum rates that can be charged by money-lenders and loan-sharks — people whose image is even below that of rapists, thieves, bankers, mining companies and politicians. The perverse result of these laws is that those with the most desperate need of money, and the worst security, are unable to borrow any money.
Perhaps the most unhealthy aspect of interest rate control has been the special interventions to maintain artificially low rates for building industry borrowers. This, plus the existence of capital gains tax on every other asset, means that the major investment of Australia is bricks and mortar — private palaces for individuals and ivory towers to house the hordes of regulators. We are on our way to becoming the most well-housed society of paupers the world has ever seen.
The long-term interests of all Australians are best served if government abandons all attempts to manipulate the price of money and reduces its demands on the capital markets for funding to cover its own profligate spending.
Unfortunately neither the government nor the swinging voters are interested in the long-term, or in efficient capital markets. They will have to be taught, by cruel experience, that neither governments nor consumers can spend themselves into prosperity.
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